Question

Which of the following cause call and put option prices to rise? decrease in the underlying stock price increase in the volatility of the underlying stock decline in the hedge ratio decrease in the time to expiration none.

Answer 1

Increase in the volatility of the underlying stock can cause call and put options to rise.Volatility refers to the degree of movement in price.It encompasses the speed and magnitude of changes in the price of the underlying asset.The reason had to do with the asymmetrical payoff structures of options. Because increased volatility can only help option prices then the market bids them higher.

In relation to the options market, volatility is a reference to the fluctuation level in the market price of the underlying asset. Volatility is a metric for the speed and amount of movement for underlying asset prices. Cognizance of volatility allows investors to better comprehend why option prices behave in certain ways.

Two common types of volatility affect option prices. Historic volatility, known also as statistical volatility, measures the speed at which underlying asset prices have changed over a given time period. Historical volatility is often calculated annually, but because it constantly changes, historical volatility can also be calculated daily and for shorter time frames. It is important for investors to know the time period for which an option’s historical volatility is calculated. Generally, a higher historical volatility percentage translates to a higher option value.Implied volatility is a concept specific to options and is a prediction made by market participants of the degree to which underlying securities move in the future. Implied volatility, essentially, is the real-time estimation of an asset’s price as it trades. This provides the predicted volatility of an option’s underlying asset over the entire lifespan of the option, using formulas that measure option market expectations. When option markets experience a downtrend, implied volatility generally increases. Conversely, market uptrends usually cause implied volatility to fall. Higher implied volatility indicates that greater option price movement is expected in the future.